Appraisal and Fair Market Value in Pennsylvania

What is Business Valuation? Business valuation is a process applied by qualified valuation experts to determine the fair market value of an owner’s interest in a business. Accounting methods and formulas may be used to discover what a business is worth. Business valuation is often used to resolve disputes related to estate and gift taxation, divorce litigation, corporate mergers and acquisitions, capital financing, and many other business and legal contexts.

Economic Conditions. A business appraisal generally begins with a description of national, regional and local economic conditions existing as of the valuation date, as well as the conditions of the industry in which the subject business operates. This section of the company appraisal provides a context in which the subject business can be studied and compared to other firms.

Methods and Formulas for Determining Business Value, Corporate Financial Statements, Company Cash Flow Statements, Asset Analysis and More

Stock market trends, gross domestic product, employment, inflation, interest rates, and consumer spending are some of the economic indicators that are usually discussed in the first section of a business valuation report. The conditions are examined as of the valuation date, which may substantially pre-date the date of the report. Business appraisers are permitted to consider only facts that are known or knowable as of the valuation date. Events that were not reasonably foreseeable on the valuation date cannot affect the business valuator’s opinion of value.

Financial Analysis. After reviewing economic conditions to provide context, the business valuation report examines the subject company. A history of the company is often included, as well as a description of the organization, its business lines, products and services, its management, customers, competitors, and employees, and its financial performance.

The financial statement analysis generally follows a description of the subject company. One of the first techniques that a business valuation professional applies is called “normalization” of the subject company’s financial statements. Normalizing the company’s financial statements permits the valuation expert to compare the subject company to other businesses in the same geographic area and industry, and to discover trends affecting the company over time. By comparing a company’s financial statements in different time periods, the valuation expert can view growth or decline in revenues or expenses, increases or decreases in assets or liabilities, or other financial trends within the subject company.

Valuation professionals also review the subject company’s financial ratios, such as the current ratio, quick ratio, and other liquidity ratios; collection ratios; and other measures of a company’s financial performance.

Appraisal Techniques. Three different approaches are commonly used in business valuation: the income approach, the asset-based approach, and the market approach. Within each of these approaches, there are various techniques for determining the fair market value of a business.

• The asset-based approach is perhaps the simplest method. By adding up the values of the assets, the expert may determine the book value or net asset value of a business. It may be necessary to adjust the historical cost value of the assets shown on a balance sheet to their fair market value.
• The income approach determines value by calculating the net present value of the benefit stream generated by the business. The appraiser might adjust the company’s cash flow statement before applying an appropriate capitalization or discount rate.
• The market approaches determine value by comparing the subject company to other companies in the same industry, of the same size, and/or within the same region.

In determining which of these approaches to use, the valuation professional must exercise discretion. Each technique has advantages and drawbacks, which must be considered when applying those techniques to a particular subject company. Most treatises and court decisions encourage the valuator to consider more than one technique, which must be reconciled with each other to arrive at a value conclusion. A measure of common sense and a good grasp of mathematics is helpful. One business valuation technique commonly used in Pennsylvania divorce actions is the “capitalization of excess earnings” technique, sometimes known as the Treasury method.

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Brian C. Vertz is a Pittsburgh divorce lawyer with more than 15 years’ experience in family law litigation and appeals, including divorce, custody, child support, premarital agreements, settlement agreements, division of marital property, business valuation, and business succession planning.

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